product quality productive efficiency and international technology doc

Thee ests point sever sic mesg, as, by imposing enough ractare onthe production function and the demand syste, itis poser measure rodut quality and marginal ox athe plac eel and toelat

POLICY RESEARCH WORKING PAPER

Product Quality, Productive

Efficiency, and International

‘The World Bank

Development Research Group

‘Macroeconomics and Growth

to orelgn snowteage through expats imparted inputs, ara foreign ect investment doesnot hep to resi curent proguct quay or proavcwe eflenoy

Pouicy Reseancis Wonkise Pavan 2759

‘Summary findings

‘Wat mechaisns mow fegueny ans foreign technologies to developing curty fers? Do these

foreign technolo affect both prodctiveefciency

and produce qui the recipient fs? Under what

‘Greumstances do fms pore aceite tha iether,

ascent foreign knowledge? “To ailres these questions, Kraay, Solow, and

"Tyhou develop anew methodology and apply the framework 0 plant eel panel dt from Calbia Mexico, and Moroso Thee ests point sever

sic mesg, as, by imposing enough ractare onthe production

function and the demand syste, itis poser measure

rodut quality and marginal ox athe plac eel and

toelat the evolton of these vase to it acy

histories Doing so, the aor fd eons feel

perstence in both quale and marginal costs, Ba in moc indy o county panels ha they stupas

iceenatonal ates hep ide in prediing cuerent

peformance ence pst relations on gui and

‘marginal cos are contol fr That ix aces donot

‘ypily Granger ete performance neering, in

the minority of ses where signican aoeiation,

hoạn, intersational aces appear to move costs abd Produc quality in he same drecion So the ne fect,

‘of profits in hee cn nor immediately apparent Second, several tase pater emerge wit spec 10 che đosemimmng of international actives, Mont fundamental, acinar highly prsen, even ser

‘unobserved heterogeneity icone for Thar sugges

‘hat ir incur unk theo conte when they nian

or cease acre 0 remporay poly oF Imseroeconomic shocks may hav longum effects onthe tera of actives observed in prt counry or Ide Also cies ed ogo toes shat sae tha telat frs performance to one iterations activity

bd igore de ors may geneate mieading

‘oncasion Bur dhe bundling of aces seems 20

‘aay refer unobserved plant characteris sch

‘managerial philosophy, comtacs product niche, and Iocan One these are contol fo, hte i cridenc that engaging in on nerationlaciity Increases the prbabiiy hat frm wil engage in obers inthe fore

“This paper—a june product ofthe Macroeconomics and Growth Team and the Trade Tea, Development Resear Groupispart of large llr he group to stad pater ofnterasonal technology diffusion The sty wasfonded bythe Bank’ Research Support Budget ande the eesearch project “Micro Foundations of ternational Technolgy Dison Cpiesof his paper ste aval fe fom the Word Bank, 1818 H Steet NW, Washington DC20833- Please contact Rina Bonfield, room MC3-384, telephone 202-473-1248, fax 202-522-3518, email address shoafeldawordhankorg Poly Research WotkingPapesateaso posed onthe Web at hepieconrldbank.og The

‘suthos may becomacted stskaay@wordaak or, Soap @otma com, orjst32@p.ed,Jastary 2002 (pages)

‘See her

Tie Rly Roach Wong Pap Sa an te dg ow pan ge eae of aa Lrvopan a coy hen he hn on hn be eg Tei eprom a so ee choo ngage te prt el ped Ta

‘srt tnt tr They Sa mel nt ie to or Bn 8 at Dc

‘Produced by the Policy Research Diseminasion Caner

Product Quality, Produetive Efficiency, and International Technology Diffusion:

‘This paper i part ofthe World Bank-funded research project “Micro Foundations of| International Technology Difusion.” We thank Welfgang Keller, Jim Levinson, Mare Melig and Mark Roberts for useful discussions and absolve them of blame for

‘methodological Naws that rem,

1 Overview

‘A casual tourist can confirm thal ecologies olen make her way rom the eveloped word to theless developed counties (LDCs) However, despite the critic importance of technology diffsion for economic developmen, the evidence on many aspects ofthis process remains sketchy: What mechanisms most fequently transmit foreign technologies to LDC firms? Do these foreign technologies affect both productive ficiency and product quality inthe recipient firms? Under what circumstances do fms pursue activites tha ghe them acess to foreign knowledge? This paper develops anew methodology for adresing these issues and applies the framework to plan-level panel

data from Colombia, Mexico and Morocco

A ‘The existing Wierature

(Our init understanding of ntemational knowledge diffision doesnot derive

‘om neples ofthe topic nthe empirical economics iteratur alone at east three

<Sfferent methodological approaches have been deployed Fit a the very micro level a umber of analysts have used casestudies and qualitative survey to generate

descriptions of leaming processes at individual firms ex, Hobday, 1995; all, 1987; Katz, 1987; Pack, 1987; Rhee, Rost-Larson and Purl, 1984) As Pak (1998) observes, this literature provides invaluable details concerning ims" effort to absor technology

Đo ha ote to say quantitatively about he results of these efforts in terms of odustive efficiency or product quality There ar some exceptions (¢g, Pack, 1987), but they are too few and based on such smal samples that they provide ile bass for

‘Beneralization

Atte other extreme, studies based on aggregated data have coelted coss- county patterns of productivity growth or productivity levels wih various proxies for counties exposure to forcign knowledge andlor thế ah to absorb it These proxies include apt goods imports (¢, de Long and Summers, 1991; Keller, 2000), ade

‘with countries possessing large RAD stock (Co and Helpman 1995; Keller, 1998; Keller 2000), foreign dirs investment inflows (Blomstrom, Lipsey and Zan, 199), and domestic patent stock (Eaton and Kortum, 1996) Unlike case stuties and

<escipive surveys, cross-country regressions document broad patterns of association,

‘and in tha sense they provide a basis for generalization However, most are subject

‘avity of econometie eritcisms, including ageregation bias, omitted variable bias, measurement eor bias, and sultant bias

Finally, plant of frm-level econometic stdies coelate proxies for firms! exposure to forign knowledge with thst productivity levels or growth aes To ita

fw examples, Aitken and Harrison (1999), Haddad and arson (1993), and Djankov and Hoekman 2000) study foreign diet investment and Chen and Tang (1987), Av and Hwang (1995), Clerides ea (1998), Kraay (1998), and Bigsten eta (1999) study exports? By sacrificing the nuance and dtl provided by casestudies, these miro economic studies gain the ability to weatlrge numbers of producer and make steal inferences They also do beter thn the macro stuiies i ems of denying

the specific conelates of productivity and avoiding aggregation bas

‘Unk he ote tices mentioned er, Enon a Karn (196) do ot tempt mpl isola cond fr knowledge tafe Amore extensive erate review maybe founda Tyhou (2000)

Nonetheless, the plan1evel eeonomeie dudies hay signiieantshodeortings too, One common problem isa filure to disentangle causality For example,

contemporaneous coreation between exports and efficiency tells us nothing about what

‘caused what Bven studies that use lagged exports to predict current efficiency may miss the knowledge transmission mechanism, as Westphal (2001) has emphasized A second

‘problem is that productivity is almost always poorly measured.” Manufactured products

re quite heterogeneous, even within narrowly defined industeies, so there is no single measure of output that can be compared across firms Real revenue is typically used as 8 stand-in for physial product, but this variable responds to product-specific pice

adjustments as wel as fluctuations in physical volume Productivity measures

‘consequently confound productive efficiency and market power Further, when

technology ffusion leads to product innovation rather than process innovation, these productivity measures may miss the effet entirely Finally, lke the cross-country regressions, studies in this literature usually Focus ona single conduit for international technology difusion and ignore the others, opening the door to omitted variable bas

on revenues, costs and market shares as reflecting equilibrium ina differentiated product market By using @ new normalization and imposing suficient demand-side structure, we avoid the problem of distinguishing real evenue from physical product We are alo able

to separately measure process innovations, which are manifest in marginal cost

reductions, and product innovations, which are manifest in heightened demand fora product ata given vector goods prices Accordingly, we can study the joint evolution of these provesses and investigate whether improvements in one dimension are

complemented or offset by changes in the other

Second, we teat multiple channels for intemational technology diffusion in a single integrated famework This would not be important if he various activities that transmit technology were unrelated to one another But because of complementartes and inivisibilites, they tend to come in bundles andor in predictable sequences" Hence econometric models that treat any one of them asthe unique source of foreign technology run considerable risk of misatribution,

‘Table 1 below lists the main knowledge-transmiting activites identified by the case study literature, Its not hard to identify reasons why firms’ decisions regarding

‘these activites will be related to one another Exporters are relatively likey to use imported capital and intermediate goods because they ae granted preferential access to forcign exchange, or because the produet characteristics needed for exporting are best manufactured with these goods Similar input and capital god requirements may

‘Migr and Rober (1990) make asm pon inter paper cn he adoption of ew technologies

‘ad erguiationalseaegies infra, thet faites The do not consider inermatnal aden goo, owtesipo© dfs womevhat fom se ut We oes on Noses,

‘heir are anne! point wasn tour sting, mars mutando—nenno-convexis ‘mplanesurtestheracerae the pro faci stmaywellbe optna adopt bundles of Besn

seeompany lieensing agesmeni Fima ih FDI are relatively likely to use imported intermedtes because the parent company can nteralize some costs by doing so

Multinationals sometimes locate plans sbrod to exploit low wages wile protecting thee intangible assets ike poprctary knowledge and product reputation, so FDI and

exporting can also be complementary activites

‘+ importation of intermediate and capital goods,

+ leaming from exporting to knowledgeable buyers;

‘leaning from final goods imported, and reaetions structures as these goods enter the country to changes in domestic market

HH Methodology

A The Conceptual Framework

‘To motivate our empirical model, we begin by sketching a dynamic model of indy evolution in which firms makes optimal decisions concerning their activity

‘bundles In turn, these bundles influence their Foture performance Although we shall not get very formal about this model, our diseussion wl allow us to be explicit about the

‘causal relationships that we assume have generated the data

Performance determinants:

Let us begin with a representation of performance determinants From the

perspective of managers, the activities in Table 1 generate revenues by improving a

mm uit production costs (c,) rte appeal of ts product (a), which we combine to fom the performance vector @,+(ay,¢,) forthe j*finm in period Then, presuming thatthe elements of ey, evolve according to auto-sepressive processes, condoned on

«exogenous frm characterises (hereafter) andthe firm's history of activity bundles

lBycb,B, si dh Ey isa serially

uncomelied vector of unobserved innovations in theo, proces, nde clus ved

of tummies 6, indicaes wich stv bunle the fem is panna tine iany*

Act đươnnlomnn

(fours, he vies thaseves are endogenos, We envision ams weighing four kindof fects on thei prof eens when choosing which combination ope, Fina desi by equation (1), stv in une are reizationson te

pevtmane tection in so ding thy may as ae ther atviy

choices and performance of competing firms Third, given the ew, realization, activity

5 hats the A cement of by tke vale of oe in pevod ithe frm i enaged inthe È*

posible bane of eves ring hat perio, and oceewise takes value srr ther ae K pole avi, , bas 2¥ elements of 20 Ina county

bundles can affet net operating profits by changing demand conditions—e g., providing access to foreign markets—or by affecting the share of operating profits retained by the firm's majority owners Finally, the initiation of activities generally involves star-up or adjustment costs

‘The speifis of these effects on profits depend upon the activity in question For example, joint ventures, subcontracting and FDI may transmit knowledge andr improve

‘firm's access to inputs, thereby affecting the evolution ofits performance vector, , These activities may also affect its operating profits by ereating new markets for is products, by branding its products, by creating profit-sharing obligations, andor by

<iluing comporate control Finally, joint ventures, subcontracting and FDI involve up- front research costs and legal fees when they are initiated

Similar observations apply to the other activities in tale 1 Firms that import Jnermediate or capital goods improve their performance trajectories by using higher

«quality inputs and by extracting knowledge from these foreign goods But they also incur higher material or capital ests and, prior fo importing, they must research foreign suppliers and leam about customs procedures Fis that employ high quality workers

‘ypically improve ther processes and their products, but they also incur higher labor costs, and they bear the sunk costs of attracting and screening job applicants for these positions Finally, firms tht export improve their earings by tapping new markets, and they may Team ftom knowledgeable buyers abroad But to begin exporting, firms must cstablish distribution channels, research foreign markets, and e-package and/or even r= design ther products

‘When managers understand these linkages and corerly anicipate he behzvior of their rivals, the activity choices ofthe firm in period canbe represented as

determined by the decision rule:

Hore the arguments of g,() include everything that helps firms predict the future pay offs fom each possible bundle: cutent and past exchange rates and demand levels, Z, the set of previous realizations on « forall industry participants,

(Bye Byy"s Bry) ste exogenous characteristics ofall industry

pedidpenl, X, = (Xu so iXie,); na seofbelcB, [,,sboạl the dessin

rules that wil be used by all ofthe other firms (When the industry sin equilib,

‘these beliefs must be consistent with observed behavior) Finally, while the information setis common toll firms, g,() depends upon j because the / firm's own characerstios and history affect its pay-offs asymmetrically from those of ll other firms

Inference

(Our basic objective isto quantify the relationships described by equations (I) and (2), We shall view significant associations between B,., and a, in equation (1) as

‘evidence thatthe international activities Granger-cause performance Similarly, when

2, helps predict 6, in equation (2), we shall view performance as Granger-causing activities In both equations the fact that we treat activites as bundles wil allow to

<etermine whether particular combinations of bundles are elaively potent performance

‘determinants, Also, given that we shall examine the join evoltion of productive

ficiency and product quality, we wil be able to make inferences about the nate of the performance effects induced by international contacts

‘Given sufficient variation in the data, this approach inference should pick up

‘most instances where knowledge soquired through observable activites enhances future product quality o productive efficiency However, thee ar some types of linkages

‘between activities end performance that it wll fil to detet For example, suppose a foreign corporation subcontracts wih particular plant to bocome a supplier fr one its products andi transmis the necessarily technical information to that plant tmay be yeas before the plant actully begins to export the produc to he buyer Ce Kim, 1997)

so when the associated exports show up inthe dat, the plants performance tjectory will ave already responded to the new knowledge and no association wil be detected, In fact, this scenario would generate the misleading econometric impression thatthe

coulsourcing stvity responded toa productivity shock rather thn vce versa

qu om (1) wil lo miss echnology diffision that does nat cura the fmm level For example, if ims acquire imported intermediate or capital nputs through an intermediary rather than by purchasing directly frm foreign supplies, the associated improvement in performance wil ot be tibued to foreign sources Silay, if finns that eam by engaging in international busines serve as valuable examples for others, the knowledge spillovers they generate wil not be attibued to foreign sources For all of these reasons the results ofthe exercise hat fllows shouldbe viewed as suggestive

rather than definitive

‘To render unit production costs observable we use a novel normalization

‘Specifically, we define one uit ofthe * plant's product o be whatever that plant can produce witha dollar's worth of intermediate inputs, Since products are differentiated

‘this doesnot imply that a plant using a elaively large amount of intermediate inputs is

‘producing a relatively valuable outpat However, if firms were to differ in the efficiency with which they convert intermediate goods into final output, this assumption would have the undesirable implication that efficiency guns reduce output when the physical volume

of final production doesnt change * Thus our normalization is accompanied by two strong assumptions: fins exhibit constant returns homathetic technologies, and these technologies differ across producers only because of diferences in primary factor

‘efficiency Tat is, some firms use labor and capital more effectively than others, and this {is the only reason marginal cost schedules differ across firms

‘With these assumptions we can calculate unit (variable) production costs and

© Varian in factor prices ars plats wl regional variation nator psig regional dames ei

‘Sopped the forthe es reprtd Here,

for inference, We cold for ound spies effect so we

\atiable costs (labor, intermediates and energy, /, be intermediate input costs ad 8,

te revenues Our assumptions also imply tha unit variable production cost correspond

to marginal cost

‘Our approach to measuring product ppel or quality is more involved Iti based onthe notion that, given the vector of prices forall avilable products in an industry (Gocluding a composite imported variety), large market shares imply high quality OF course, market shares reflect more than product characteristics, so one shovld think of

“quality” sa broad measure of produt appeal that responds to reputational effets and advensing as well as physical characteristics ofthe products

To impute this quality notion fom prices and market shares we needa demand system and a markt oxulibrium concept For these we us La and Tybout’s (2000) aptation of Bey (1994) representation of a diferente product matket, which in

‘tums based on MeFadden's (1974) nested logit demand system ad the generalizations

<eveloped by Berry, Levinsohn and Pakes (1995), The following paragraphs paraphrase {Luand Tybout’s (2000) deployment of Berry's (194) model

‘The Demand System

We begin by assigning each producer in the industry of interest to one of G aengraphi region (nests) Producers in ll regions compte wih one anther and with

« composite imported good, but consumers view products within a region as closer srbslles thin prods coming from distin regions The price a he composite

‘imported good is exogenously determined by the weal exchange rae There ae N

domestic establishments, indexed by je (1 V}, each supplying its own unique variety

So counting the composite imported good (identified by j= 0) there ae N+! available

‘varieties Finally, © she set of produc varieties inched in product's nest isting prods

‘Domestic consumers have heterogeneous tases, indexed by the real number

46 (.L,] Bach period, each consumer inthe market chooses a single unit ofthe variety that yields him o ber the largest net indirect tity, where variety yields consumer € net

1 Py forthe N domestic vaveties and iy = Ey ~Y-r, fo the imported

varity, where &, exes the “gait” of good and p and arte prices ofthe donssde gosds andthe domestic cuency price ofthe imported composite good,

renpectvly

‘The lst wo tes on the right hand side of 2) re unsbserved eno components that capture individual taste difeences The ist component vres across nets but sot within them, while v, exhibits withinnestvaraon By assumption, bth

[¢ +v]andy are distributed type-I extreme value across consumers, with variances

(6) /3 and (13a) 13 respectively The inet tility funtion parameters

‘are identified onl up toa scalar multiple so we impose 4, = 1.” Also, we define

“Anderson, Palin un Tis (192) show that on can hak ofthese cor components a ‘efleingbeterogeneous ste over unaburved produc chances From at pnp,

‘Ackerbrg a Ryman (2001) sage tat nj be ade econ ofthe numberof rods,

‘sce the adios of mre pout a markets helt crowd product sac and eflecivey reduce {he nperoa nts cron products We experimented wit ks geeralation sound 20 cs

st dependence of the er componeat vacances on tember of products lll avabl

B

‘As goes te, the wth groupcoeaton of tities eestor, dasa ape tun,

‘itesrp cael oes iy

years? Then, using these equations and the defini of Hits possibleto solve forthe

‘quality of domestic ood /by using the expressions for mean uty

Finely, we obtain our quality/ppeal mesure, a, by expressing, relative othe

quality of imports Specifically, without loss of generality we st the mean utility from Imports to zero (i, = 0) and we measure the quality of domestic good j relative to the quality of imports as:

‘we sre complete ps-rovp This impletion consent vi ur expressions Ist ses and pies, wch re sed nthe premise tha be price ofthe use good doesnot fer qm

‘eond eds he pts of te domestllyprodieed vis, Whe he epic Feature suggerts are dlr pices of imported gods ariel to speed soe o exchange ale

‘uetanons (Knee and Goldberg 1999), or essumpton es tot seem oa fom aly

1

‘Then we estimate these equations jointly with the equilibrium price relationship that

‘obiains when firms compete Betrand-Nash inthe prodvet market (Bery, 1994: ©

woolen ee | ch lu o

“Tavis we esinat th demand parame ath sane tine hat we estate

pecans desing theft ofintematna seve on ech dimension of

performance (4 and ¢*)

iit win pi a tal lth Nad

(2) First, if reflects measurement eror in costs or intermediate inputs it wil be correlated with the right-hand side variables in equation (7) Unlike Berry (1994), we assume this problem away by positing thatthe noise in equation (7) comes from

exclusively from measurement error in revenues (and thus in prices)

‘Thisconion presumes that te (common know) petformance Year (yy, Oy

‘is reaiae tte bean of ech prod and that fae tse te indus do at depend pon cet rice and tay cies, given, mo, Alb, mined sates inthe prods

‘nuke competition ‘eltinbetven prac mtt competion and indy dams) ae dislowed (Se ieae a Pale (195) fra formal discussion of the Luan Tybout 2000) cscs some aertive ways 0 allow for ose in (2; they complicate the

‘ination precede but can be feasibly implneted We pan explore te proper fare

Second, ifthe disturbance terms e7 and Z7 are anidly corelated they vi not

be orthogonal to lagged endogenous variables (4, Iyar€y-q) ad spurious corelation

‘ates may result Ther rc two standard ways ode wth his problem One to

choose a sufficient lon la length (0) that al persistence inthe endogenous variables

is absorbed bythe explanatory variables, leaving 6 and serially uncomlated This

solution is simple and appealing, but in short panel ke ours it means sacrificing most of

‘the ime series information in the data Since time series variation is key for Granger

causality tests, we choos the oer standard approach Thats, we assume thatthe eror

terms are characterized by a standard erro component specification and we eorect for

the associated inital conditions problem (Heckman, 1981)

Specifically, we write the disturbances as €% = pf +0} and ef = uj +05,

where-varoh)=22,,varlut)=o3,, cov ) 20 We, eov(o3,0}

LO Opty 5p hyp) Igy ip kph si SO Oe k shy )80 l8,

‘Then we express 1,88 a inear projection on and the temporal mean of x, plus a

residual plant effect:

„

nly, we subsite his expression for 1, into th density fron shove conioned

on ands, and weintegrate out the unobserved plat ets = a) Since sis onogonal oy by consration spot imines te inal condions problem andthe compound disturbance vec, f.05)+ has andar cư

‘components properties." We use a fll informetion maximum likelihood estimator forthe system (1a), (1b), (6), (7), and (8) presuming that al disturbances are normally

distributed

‘Our final methodological task is to develop a version of equation (2) that ean be

‘estimated Stuctural estimation ofthe deep parameters is out of the question, given the

‘complexity ofthe optimization problem and the numberof parameters involved Instead,

we assume thatthe probability of choosing the # activity bundle canbe writen as 2 reduced-form linear expression inthe observable arguments of g,() Also we drop all Jags of more than one year and we summarize the performance of competing firms with & cross-firm average of o, excluding the /* frm, hereafter 7

bw =ố, By, 4 Oy, HN l2“ @)

‘Noe tht we ae aru g's dependent fp ugh ony not be,

a picpe, a muhtnomil probit veron of he decison ule could be esti sig te sulted

‘mebod of moments (Geveke, Keane and Kune 997 However, is approach dieu apply

Ân đit becnse ve đong ate any fm spec ifomaton on arabes tt ae ie

‘ly of cite eeices (Keane, 1992) Extensive expeineaton Wh hes us proved

(Unlike in equation (2), firms’ choiees of activity bundles are not deterministic here

‘because we do not have access to the entire information tha they base their decision spon.)

‘As with equations (Ia) and (1b), we adopt an error components specification for

the dituebances, c=} +0, and we addres the associated inital conditions problem

‘sing Wooldige 2000)s technique, Thats, we expres ach clement of the vector

as linear function ofthe vector of initial states by» plus noise

Inprincple there are some efficiency gains tobe reaped by estimating the sytem

‘of equations 2" jointly with those in the system (Ia), (1b) and (7) above, However, so long asthe residual plant effects in equation (2) are no corelated with 1” in equations (19) and (1b, this

not necessary for consistency We therefore opt keep the model

‘manageable and estimate the activity determinant equation separately

on only a subset, The Colombian data reveal wheter firms are exporting and whether

‘hey are importing intermediate gods; the Moroccan data identify expos and firms

‘with foreign owners (FDI), andthe Mexican data identify exporters, importers of

intermediate goods, and importers of capital goods Thus, although no single country

spon the ere set of activities, tween them we observe a uty large colleton of

«conduits for international technology transfer

For several reasons, we shall fews ou mpivical analysis on manufactured chemicals Fest, to teal ofthe establishments in our datasets would be 2

overwhelming ask Second, among the sectors with suficlent observation o support

inference, the chemicals industies are relatively prone to engage in international

sctiviies, Thin, these indies also rely cativey heavily on scientists, technicians and cngineers, so when technology diffusion takes place, we ar likey to find it among them Fourth, in most chemicals industries, imported final gods are sufficiently important to play the role ofan ouside goed in our demand system Finally, the chemicals industies are wel represented in each of the countries, Ths cos-country comparisons allow sto examine wheter particular types of prodtion are prone to particular paters of

technology absorption,

‘We sal lo limit our analysis to plants that re preset ring all years ofthe analysis, (For Colombia, the sample period is 1981 through 1991, for Mexico itis 1986

‘trough 1990 and for Morocco itis 1986 through 199.) Exclusion of entering and

‘ting plants obviously opens the door to selection bis in our ndings, butt

substantially simplifies the econometric modeling, We fee ths price worth paying because the omited firms supply avery small faction a the matket More importantly,

‘were les concemed wih precise parameter estimation than with simply asking whether significant pattems of association are present It is highly unlikely that they would be

‘manifest only among the new and dying plants that we leave out of our panels

20

‘A Performance determinants

‘Our results foreach 4-igit chemicals industry in Colombia, Morocco and Mexico are presented in tubles A2,1 trough 2.3 of appendix 2, respectively (Industries with fewer than 10 plants continually present are not reste.) Parameters of the covariance _matrces forthe compound disturbances are not reported to conserve space, but we do

‘report the coefficients from equation (8) tat relate the unobserved plant effets, "and

10 inital realizations on the performance variables, a, and ¢,

Under each industry heading the left-hand column reports parameter estimates and the right-hand column report the associated standard erors Wa tet statistics for the ml hypotheses that product quality is unrelated to international activities and

marginal cost are unrelated to international activites are reported near the bottom of cach able, All coefficient estimates that are at least twice their standard ero are reported

in bold as are z” statistics with p-values less than 0.05 The degrees of freedom forthe

‘Wald statisties depend upon the number of activity bundles thet are considered, which in tum vary across countries and industries (The ater occurs within a country because some industries donot exhibit ll posible activites.) Parameters, standard erors and test statistics that desribe the relationship between activities and performance are reported in shaded panels,

Demand parameters

Parameter estimates forthe demand system appear inthe top pane! of each table [Note thatthe parameter that measures the sensitivity of indirect uly to pies always quite significant and postive, as hoped This gives us some confidence thatthe

price measure implied by our normalization rule contains information relevant to

2

consumers Is generally higher in Moroco than nthe eter countries because the French accounting system thee led toa unit pice measure ther that was somewhat lower than the measure we calculated for Mexico and Colombia; hence the mad

assigned that country higher demand elasticities

Estimates of are also quite accurate They imply that for most industries, the standard eror of ¢ + is roughly twice he standard err of alone Or for given

‘consumer, indirect ules vary subtatally across regions, as well as between foreign and domestic varieties (t would be straightforward to use these igure to calculate measures of ewn-rgion or home marke bia, but we have not yet done so)

Finally, y measures the effet ofan increas in the price of imported goods onthe rlatve utility attained from home goods This parameters no estimated as accurately ax the other demand parameters because itis identified solely by temporal variation, andthe umber of years we observes limited Nonetheless, it is positive in cight of the nine cases where itis statistically significant atthe an level (Fhe exception ithe

detergent industry in Colombia.) Overall, then, our estimates of he demand system conform very nicely to priors

Product quality determinants

“The next panel in ables AI through AL3 reports estimates ofthe parameters

‘hat appear in equation (a Before considering the parsmtesof primary intrest let us recap our results onthe control variables First, conditioning on lagged performance and intemationl activites, most industries we analy in Colombia nd Morocco showed

no significant trend in relative quality The except 1s were Colombian detergents and Moroccan detergents and pants, each of which exhibited a tendency to improve relative

2

to imports over the sample period Mexico, in contrast, hosts a number of ndustes that fell increasing behind imported subsites during the sample years, Rubber products and

‘Pharmaceuticals tended to improve but five ofthe six remaining industes showed significant negative trends

(One might expect that plants begining the sample period with large capital stocks would exhibit relatively high quality, since iil capital stocks should reflect pre- sample demand for their products Indeed, nal ofthe industries wher intial capital stocks proved statistically significant, they were positively comelated with relative

‘product quality This relationship might sem spurious, since product quality is related 10 marketshare by the identity (6), and firms with large market shares surely have large capital socks However, consumers are only about prices and product appeal, not productive capacity So, ifour mode! is comeetly specified and prices are property measured, any relation between relative quality and inital capital stocks is indeed a

‘consequence of interaction beeen quality and size

‘The next conrl variables are lagged quality and lagged marginal cost The formers significant in almost al ass, implying that our quality measure follows an autoregressive process, conditioned on othe regressors Given that product

characteristics and reputation evolve slowly over time, this is what one would expect to find In most cases the AR(1) coefficient is significantly les than unity, but Colombian pharmaceuticals and Mexican ferilizerspesticides yield roots close to one (We have not tempted unit oot tests for ou system.) Coefficients on lagged marpnel cost are usally unimportant, 0 for most industries marginal cost shocks have litle effect onthe

absequent evolution of product quality Inthe four industry/country cases when lagged

2